Having finished my reading on CBOE's method of calculating the VIX on out of the money call and put options written on S&P 500,I have a thought about the ability of market making firms to manipulate the market. The calculation of VIX uses option prices with positive bid price, and each option contributes to the implied volatility as a whole. So, is it possible for a market-making firm to go long in VIX futures and immediately provide a bid price for out-of-the money options?
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1$\begingroup$ What you describe is very similar to the allegations made by a whistleblower recently - see assets.bwbx.io/documents/users/iqjWHBFdfxIU/r8LCxXQ4CfqU/v0 for the letter sent by his/her lawyers. $\endgroup$– LocalVolatilityFeb 28, 2018 at 7:41
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Definitely - but I would look to see how much that 1 additional bid price of 0.05 or more would impact the price of the index. Or, try doing it with 10-15 more bids (or however many). The index is weighted to at-the-money options much more, noting "Contribution by Strike":
I'm also a little uncertain how live bids are manipulating a market. If you think the bid is unwarranted, sell it! (Perhaps this is a little contentious - it reminds me of the DRW bid scandal. I was unsure of my opinion then, too.)
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1$\begingroup$ While reading a paper from J.Griffin and A.Shams about Manipulation in VIX,I came out with this. If the manipulation window is the settlement day,usually Wednesday for derivatives on VIX,then the manipulation should take place in this day's market open,since Tuesday is the final trading day. So,the recent rise of VIX happened at 5th of February, Monday. Could traders influence Monday's prices or is it an uncorrelated phenomenon? $\endgroup$ Mar 6, 2018 at 8:47